The Ugly Story Of USL's Balance Sheet!

Last week India’s largest booze company United Spirits wrote off Rs 4359 cr; thereby eroding it’s networth by half. USL will now have to file with the BIFR under the Sick Industrial Companies Act. While that may be a technical filing, the nature and extent of write –offs are very grave and suggest more to come. Sajeet Manghat and Payaswini Upadhyay find out what went wrong, why and who’s to blame?

After a delay of 3 months, the United Spirits Board finally signed off on the company’s FY14 balance-sheet last week. The numbers are finally public and they tell an ugly story - of rampant and opaque intra-group financing, diversion of funds and maybe also the failure of the company's internal audit functions.

USL has made 3 sets of provisions in the FY14 balance sheet. The first has to do with Whyte & Mackay.

That’s a UK based company acquired by USL in 2007 and sold in 2014 on directions of competition authorities. USL says the net proceeds from the sale of Whyte & Mackay will be insufficient to fully repay the intra-USL group loans taken to purchase the company. The reduction in Whyte & Mackay’s value and subsequent diminution of investment value in 2 of its arms prompted an exceptional provision of Rs 4321 crores.

Amarjit Chopra Former President, ICAI“If this kind of provisioning is required - more than Rs 4,000 crore is the diminution in the value of the subsidiary’s investments for that particular matter - it can’t happen overnight and to me it must have continued for years together.”

Santhana KrishnanManaging Partner, PKF S&S“As far as the valuation of the investment goes, probably because of the poor economic conditions and over valuation of the brand itself, it could have resulted in a loss. That loss is more in my opinion not with any devious intentions but could be because of valuation methodologies and hope on the future.”

The second set of provisions is for doubtful debts/advances and loans. These doubtful debts throw up 2 important issue s- whether the provisioning is adequate? But more importantly whether these doubtful debts are also connected to diversion of funds.

USL has provisioned Rs 1123 crore towards doubtful debts - this includes Rs 649.55 crores for prior periods as assessed by the company. But it’s not clear what the total amount of doubtful debts are and whether this is a full or partial provisioning

Amarjit Chopra Former President, ICAI“What is surprising to me is that if they say that out of an X amount only 10, 12, 13 or 15 percent is only to be provided - whether it is based upon certain criteria or is it that in the other cases litigation is not there that I don’t find. I personally feel that in all those cases which have been given, the litigation has been there but only certain percentage thereof has been provided for. To me it may not be possible to say whether it is adequate or not adequate but I personally feel that the auditors would have had gone deeper in to the matter and must have satisfied themselves with regard to the provisioning.”

Not just the amounts but the circumstances that led to the creation of these doubtful debts are equally shocking!

The USL management reveals that that over Rs 600 cr of advances and loans provided to some entities are now being disputed by those entities. These were advances by USL to tie-up manufacturing units. The advances were meant for enhancing capacity, obtaining exclusivity and lease deposits. But the tie-up manufacturing units now claim that they borrowed this money but in turn advanced these amounts to certain UB group entities and will only be able to pay once they recover their money from the UB group entities.

The USL management says, "the claims made in relation to the advances to the parties may indicate that all or some amounts may have been improperly advanced by the company to such parties for, in turn, being advanced to the alleged UB group entities."

The board has authorised a detailed inquiry into this diversion of funds and the auditor has played the safe, waiting game saying - ‘Pending such inquiry, we are unable to comment on the nature of these transactions; the provision established; or any further impact on the financial statements..’

Santhana KrishnanManaging Partner, PKF S&S“At least from the accounting notes that have come it’s very clear that these monies have been diverted. However, also you can’t wait for one and a half years and still say that I am unable to express an opinion. Three, very interesting to note, who have been the auditors of those group companies. If it was the same auditor, you can’t say that I didn’t even know about it. However, very important is these kinds of payments that have been made for enhancing the production capabilities all that could have easily been verified with the reference to your board resolution and whether any money has actually been spent on this.”

The 3rd set of provisioning relates to USL’s unsecured loans. And the question that needs answers is if the extent of provisioning IS adequate?

Over and above the advances that have been partly provided for, USL has clubbed Rs 1337 crores of receivables from Vijay Mallya owned UB Holding and classified them as unsecured loans. The new management at USL believes it will be able to recover the loans from Mallya’s company. Hence it has for provisioned only Rs 330 crores towards principle outstanding. It has also stopped recognition of interest income of Rs 96 crores as a matter of prudence. The management says it hopes to eventually recover the entire Rs 1422.31 crores.

Amarjit Chopra Former President, ICAI“These kind of transactions are seen rarely and I have not seen anywhere else, very frankly, that you consolidate all kind of, whatever receivables were there from UB, you consolidate them into one and you say that you have to recover this particular X amount but then there is a moratorium period for six years and total repayment period is eight years, I am baffled.”

Santhana KrishnanManaging Partner, PKF S&S“I don’t think it’s very rare and when the world financial crisis came in that is what the banks had done in terms of mortgage loans and they did exactly the same kind of things probably under different heads and under different manner. However, I think something which the management should completely desisted from doing and the auditor should have said this is unacceptable behaviour from the management.”

The 3 sets of provisioning - repayment of loans, doubtful debts and unsecured loans- and the factors surrounding them give rise to 1 question- the role of USL’s auditors.

The current auditors have qualified that financial statement of earlier years and consequently the opening balances may have been incorrectly stated; thereby questioning the work of previous auditors who were responsible for the balance sheet up to March 31st 2013. USL’s Board has also recommended that specialists relook at the accounts.

Santhana KrishnanManaging Partner, PKF S&S“It is not as though that overnight these items do become bad or you suddenly unearth it. Did he have leads and you didn’t pursue them, could be one of the questions that they will have to ask. The second is, the auditing standards very clearly establish you can’t just depend on confirmation. You are supposed to be doing additional work to ensure that this confirmation is only one of the methods by which you satisfy yourself. In my opinion they will also come under scrutiny.”

Amarjit Chopra Former President, ICAI“Till last year the reports are totally unmodified. There was absolutely no qualification; there was absolutely no disclaimer on any of the points. These are absolutely clean reports with regards to the various issues. So I think if at all we have to talk about the auditor, it is those up to March 31, 2013 before we talk of the audit for the year 2013-2014.”

Several undisclosed intra-group transactions, possible diversion of funds, questionable auditing – will all this add up to criminal action against the previous Board and management of USL?

Santhana KrishnanManaging Partner, PKF S&S“As far as criminality is concerned it is established that these are accounting entries and what is stated in the notes on accounts and in the auditor’s qualification are reasonably proved out. Obviously they will very clearly come under the present definition of fraud under the new Companies Act and old Companies Act having been repealed, the new Companies Act will call this as a fraud and all criminal provisions will apply for all this.”

Amarjit Chopra Former President, ICAI“If it can be proved that it was in the knowledge of the management that these things were happening, I think the boards which is supposed to act in the fiduciary capacity, the board which is supposed to act diligently, the board which is supposed act in the interest of the various stakeholders probably there may be liability.”

These are just some of the problems revealed by USL’s FY14 balance sheet – they clearly raise enough red flags for regulators like SEBI and ICAI to look into the accounting practices at the company. Similar scrutiny of other Mallya companies might also be prudent.